Life Insurance: Secondary Market Size And Scope

The secondary market for life insurance is a legitimate and evolving market that can offer significant value to both policyholders and buyers. It is a marketplace where existing life insurance policies are bought and sold, providing liquidity options for policyholders who may prefer to cash out their policies rather than letting them lapse or surrendering them for a diminished surrender value. This market facilitates transactions that can result in superior financial outcomes, especially for those facing urgent liquidity requirements or unexpected healthcare costs. The secondary market primarily includes two types of transactions: life settlements and viatical settlements. Life settlements generally apply to insured individuals over the age of 65, while viatical settlements are reserved for those diagnosed with a terminal illness. By participating in these transactions, policyholders can achieve immediate financial relief, enhancing their financial security and flexibility.

Viatical settlements

The secondary market for life insurance is where life settlements and viatical settlements take place. This is where existing life insurance policies are sold to third-party investors. A viatical settlement is a financial tool that allows someone who is terminally or chronically ill to sell their life insurance policy for a lump sum of cash. The buyer of the settlement then pays all future premiums and becomes the beneficiary of the full amount of the policy when the original owner dies.

The rate of return on a viatical settlement is dependent on when the seller dies. If the seller lives longer than expected, the return will be lower, and if the seller dies sooner than expected, the return will be greater. Because of this uncertainty, viatical settlements can be extremely risky from an investment perspective.

In many jurisdictions, a viatical settlement is defined as a life settlement where the insured has a life expectancy of less than two years. The term viatical settlement comes from the Latin viaticum, meaning "something received before death". The legality of reselling life insurance was established in the 1911 case of Grigsby v. Russell, but it wasn't until the AIDS epidemic in the 1980s that a true secondary market for life insurance began to take shape. During this time, many terminally ill policyholders needed cash to fund their treatments, so they sold their life insurance policies, and investor demand grew simultaneously.

Life settlements

Before selling a life insurance policy, it is important to research the market value of the policy and understand the legal and tax implications of the sale.

Primary vs. secondary market

The primary market for life insurance is where insurance companies initiate original policies. When a client fills out an application with an insurance company to obtain a new life insurance policy, that transaction happens in the primary market. The buyer is the policyholder, and the seller is the insurance company. Typically, the policyholder and the insured are the same person. However, if they are not, the policyholder must have an insurable interest in the insured, meaning they would suffer financially if the insured passed away.

The primary market can be thought of as the "new car dealership" of the insurance world, where direct sales are made from the insurance company to the policyholder.

The secondary market for life insurance is where existing, in-force life insurance policies are bought and sold. In this market, the buyer is an investor, and the seller is the original policyholder. The policies that change hands are already issued and in force. Unlike the primary market, the buyer in a secondary transaction doesn't need an insurable interest in the insured. When the transaction closes, the buyer becomes the new policyholder, but the insured remains the same. When the insured passes away, the insurance company pays the death benefit to whomever the buyer has named as the beneficiary.

The secondary market is similar to the "used car dealership" of the insurance world, where existing policies are sold by the original policyholder to a third-party investor.

There are two types of transactions available on the secondary market: viatical settlements and life settlements. Viatical settlements are available to terminally ill policyholders, while life settlements are available to senior policyholders who have not been diagnosed with a terminal condition and are generally over the age of 65.

Benefits of selling a life insurance policy

The secondary market for life insurance is where life settlements and viatical settlements occur—these are transactions where life insurance policies are sold to third-party investors. While the secondary market remains largely unknown to many policyholders, it can be beneficial for those looking to sell their life insurance policies. Here are some advantages of selling a life insurance policy:

Large Cash Payment

A sale on the secondary market can result in a large cash payment, allowing clients to cash in on the cumulative investment made in life insurance premiums. The cash payouts can be substantial and provide financial flexibility to cover living expenses, healthcare costs, debt repayment, or emergency savings.

No More Premiums

Once the policy is sold, the new buyer is responsible for paying all future premiums. This can be especially beneficial for those struggling to keep up with premium payments, as it eliminates a recurring expense and helps to reshape the seller's budget and reduce living expenses.

Higher Payout than Surrender

Selling a life insurance policy on the secondary market typically results in a higher payout compared to surrendering the policy back to the insurance company. A policy could sell for as much as 60% of the death benefit, which is significantly more than the surrender value.

Liquidity and Financial Flexibility

Life insurance is a long-term asset, and selling it on the secondary market can create liquidity, allowing individuals to shift wealth into other assets, such as a smaller insurance policy, an annuity, or traditional securities. This flexibility can help individuals adapt to changing financial circumstances and needs.

Converts an Old Investment

Selling a life insurance policy can turn a locked-in cost into a larger cash payout, providing individuals with immediate or long-term financial benefits. This is especially useful for policies that no longer suit an individual's lifestyle or needs, allowing them to convert an old investment into "found money."

Key considerations before engaging in the secondary market

Before entering the secondary market for life insurance, it is important to carefully evaluate the potential benefits and risks involved. Here are some key considerations for policyholders:

Evaluating Policy Value

Understanding the value of your life insurance policy is crucial when considering a sale in the secondary market. This involves assessing various factors such as health status, life expectancy, premium payments, and the policy's face value. Market conditions, including interest rates and demand for life insurance policies, can also impact the valuation. Obtaining professional appraisals and staying informed about market trends will help policyholders make strategic decisions and optimize their financial outcomes.

Understanding Legal and Tax Implications

The legal and tax implications of participating in the secondary market should not be overlooked. Policyholders should be aware of potential tax liabilities arising from the sale of their policies. Profits from the sale may be subject to income tax, depending on the difference between the amount received and the total premiums paid. Additionally, it is important to understand the applicable regulations, including federal and state securities laws, to ensure compliance and avoid unintentional violations. Consulting with a tax professional or financial advisor can provide tailored guidance in navigating these complexities.

Finding a Reliable Buyer or Seller

Identifying a reliable buyer or seller is essential for a fair and beneficial transaction. Policyholders should research potential partners by utilizing online resources, reviewing user ratings and testimonials, and familiarizing themselves with industry standards. This due diligence helps to assess the buyer's or seller's reputation and historical performance, ultimately impacting the financial outcomes of the transaction.

Researching Potential Partners

Conducting thorough research on potential partners in the secondary market is of utmost importance. Policyholders should evaluate the reputation and experience of potential buyers or sellers by seeking insights from online resources, user ratings, and testimonials. Familiarity with industry standards will help distinguish reputable entities from less reliable ones. This comprehensive assessment ensures well-informed choices and maximizes the financial benefits of the transaction.

Understanding the Transaction Process

Policyholders should carefully evaluate the offers presented by various buyers, comprehend the terms outlined in the agreements, and research the companies or individuals involved. It is crucial to consider not only the immediate financial gain but also the long-term implications, including potential tax liabilities and fees associated with the transaction. By scrutinizing these elements, individuals can make informed decisions that align with their financial goals while minimizing risks related to their life insurance assets.

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